Week 31: The Nation Gets Downgraded

August 6, 2011 – The week began with Congress and the President finally agreeing to a budget. It was an uneventful affair that was completed in the 11 1/2 hour – too little too late. However, much like a any fight, the damage has been done: the general view by the public has been one of disgust at the entire episode. It may have been Washington’s lowest moment in years. In the end, there were no winners and the only outcome of the entire episode has been to prove how out of touch those in Washington are with reality. The nation was looking for leadership and creative thinking on how to address the debt issue. Instead we got the same old partisan rhetoric being heaped upon as a justification as to why those we elected simply could not do their job. (Hint: when the house is on fire, it’s OK to be flexible and tell the kids its OK to get out of bed! )

And so it is that while those in Washington eluded the elephant in the room and put emphasis on what should have been an administrative function (creating a budget) , the elephant came to them: the Standard and Poors rating agency lowered it’s rating on U.S. debt on Friday from AAA to AA+ : the first time in history. This change in rating means that the debt of the U.S. is no longer considered risk free. The reason for the downgrade was,“The downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenge,”

For investors this is a cause for concern. The foundation of investing is based on a risk free rate. The riskiness of assets is measured against the one investment that was supposed to be risk free: short term U.S. Treasury bonds. This is not to say that short term Treasuries are today riskier then they were yesterday, but instead to point our what we observed last week. Actions have consequences – politicians were being cute implying that the U.S. might skip a payment; today’s downgrade (which should be an affront to all Americans) is the result of those in Washington playing chicken with the budget.

Adding to investors concerns was a week of mixed economic news. In May the U.S. posted 117,000 new jobs – higher than expected. However, the general sentiment is turing to a concern that the nation is headed towards a double-dip recession. My guess is that we actually never left the first recession and that all the government stimulus (QE 1 and QE 2) was a mask of a much broader issue that most Americans have yet to understand, but is all the more sobering.

So what’s going on? The truth is that for over 30 years the nation has bought into an economic theory that simply has proven itself not to work. This is not to find fault with those at the University of Chicago who promoted neoclassical (uber-conservative) economics, but the sad truth is that the more free trade we have pushed, the more taxes that were cut, the more we removed regulations, the less the general welfare of the average American has improved. While the top .01% of all Americans have benefited from the policies of the past 30 years, the remainder of the nation has floundered. The only reason that the tax cuts of the past worked was that the government never really cut spending. It was like we were using a credit card – a grand illusion. What we need is a new direction. Unfortunately, what we have in Washington appears to be a ship of fools.

With little direction and no convincing news, the markets sold off in one of the worst weeks of the year. The selling appears to be more the result of investors losing confidence in the U.S. and many governments in general (especially those in debt ladened Europe) than a reflection of the actual performance of any one company as almost all stocks were sold off this week. It is interesting, because in doing so, the markets are lowering the values of many companies that have solid fundamentals and a healthy outlook. It is times like these that stock pickers can do quite well.

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